The crazy rise of GameStop, AMC, and Dogecoin left many of us thinking, “what the heck?!” If you're like me, you might've even (shamefully) felt some FOMO. “2000% gains in just a few months!!! If only I'd invested a little bit of money…” Known as “meme stocks” or “meme picks,” these companies have been all the rage in 2021. So I might be bursting your bubble by saying you should AVOID these stocks like the plague.
In today's post, I'll review why you should avoid investing in meme stocks. You'll hear about my technical reasons and my OWN experience investing in GameStop. Hopefully, by the end of this post, you'll feel less left out the next time a meme stock goes on a run. Let's dive right in!
What Is a Meme Stock?
Before defining “meme stocks,” it might be helpful to start by defining what a “meme” is.
Google defines a meme as “a humorous image, video, piece of text, etc., that is copied (often with slight variations) and spread rapidly by internet users.”
Originally, memes were just pictures with text superimposed over them, but over the years, “memes” have grown to be synonymous with any inside joke, which has become a large part of internet culture.
Memes are often associated with people between the ages of 12-18 because whatever they find funny typically spread around quickly. Likewise, memes have gotten wackier as time has passed because each generation is wackier than the last. I'm 18 and don't even understand some of the memes nowadays!
Stocks and Memes
“What does this have to do with stocks?” Again, memes started as funny pictures but, with time, have spread to cover almost every industry. Finance included.
A meme stock is simply a stock with no actual fundamentals or good profitability but merely is of interest because the internet deems it funny if it rises. Example:
“Hey, you know that stock of the game company? Yeah, that game company that is almost bankrupt and that Wall Street expects to fail? Wouldn't it be funny if we got together a whole bunch of people and ALL bought the stock to send the price sky-high???”
People start to buy the stock, which causes the price to rise, which causes more people to notice and also makes the “inside joke” funnier, which causes more attention, which makes more people buy the stock… It's a reinforcing cycle that can pump stock prices very high.
If you still don't know what meme stocks are, you can think of them as “joke stocks,” which have no proper fundamentals but are being bought because people find them funny.
The Risks of Investing in Meme Stocks
If you DO understand the meme stock cycle, you might think, “hey, that sounds great! If I can catch the beginning of the meme stock popularity cycle and ride it to the top, I'll make millions!”
True, you could, but you could also LOSE millions. Here are just some of the risks associated with meme stocks.
Absolutely No Fundamentals
Almost by definition, a meme stock will have terrible fundamentals.
After all, the whole point of a meme is for it to be funny. Now tell me which event is more amusing:
a) Millions of retail investors cash out their bank accounts and put them into long-time performers and profitable investment funds Berkshire Hathaway
b) Millions of retail investors cash out their bank accounts and put it into an obscure, almost bankrupt videogame company that NOBODY was interested in and which all of Wall Street was shorting
The more well-known and profitable a business is, the less likely it is to be a meme stock. The more obscure and random stocks fall into the meme stock category. (can you imagine Google, Facebook, Coca-Cola, or Apple being classified as a meme stock?)
Warren Buffet once recommended thinking about buying stocks as buying the entire business. By this logic, why would you ever want to invest in something with poor fundamentals? There's no WAY you'd buy a business with terrible fundamentals, so why would you buy its stock?
If you answered, “so I can sell once it peaks and make a quick profit,” you aren't in the domain of investing anymore. You've entered the field of trading. And statistics show that over 95% of FINANCE PROFESSIONALS can't beat the market over the long run. The odds are certainly against you either way.
This may not surprise you, but anything lacking fundamentals will be volatile. Just take a look at GameStop's performance over the past few months.
This may not seem THAT crazy until you realize that between January and March 2021, it's gone as high as $400 and as low as $18.
In his book The Psychology of Money, Morgan Housel mentioned that conviction plays a massive part in your long-term financial performance. If you're more convinced of the stock, you'll stick with it during the tough times and not sell.
One MAJOR factor that influences conviction is volatility. It's not easy, even for the best fund managers, to hold on to a stock they see dropping like a rock one day and skyrocketing the next. Couple volatility with no inherent fundamentals to back it up, and you're left with a stock with ample reason to sell at any sign of trouble. Selling low and buying high is the OPPOSITE of what good stock investing should be.
If you think you can tough out the volatility and lack of fundamentals, one final opponent awaits you: meme stocks are ALL hype.
With regular businesses, you can gauge when to buy and sell. You buy when you feel the industry is undervalued relative to its fundamentals and when there's growth potential. You sell when you feel like the company is overvalued and there is no more growth potential (based on market conditions and your outlook on the future).
Meme stocks are different. Because of the lack of fundamentals, meme stocks only rise because of the hype surrounding them. People buy the store because they think others will jump on the bandwagon and start selling when they feel like others will start selling. This makes it near IMPOSSIBLE to invest accurately.
Not only do you need to predict whether or not the hype surrounding a stock will continue (to buy the store), but you also need to predict whether the hype will die down soon (to expect when to sell the stock). These are tasks that even the best psychologists/influencers/traders have trouble doing.
And the cost of not doing so accurately could cost you your whole position.
Case Study: My Experience With Gamestop
I've been harping on why investing in meme stocks is a terrible idea this whole time, so it might be a bit ironic that I invested in Gamestop a while back. To be clear, I only bought one share, and it was with money that I didn't need anytime soon. But still, looking back, I definitely should not have invested.
The breakdown of events goes something like this:
- Jeff sees news about Gamestop
- He ignores the information because he is a sensible investor
- Then he sees more details about it and more social media exposure about Gamestop
- Gamestop rises EVEN MORE, and Jeff starts to feel antsy
- Finally, Jeff decides to buy one share “just for fun” at $360
- Gamestop immediately plummets after Jeff's purchase
- Jeff gets scared of the plummet and sells the same day, netting a loss of -$150
- Jeff takes the remaining money and tosses it into a SPY ETF
Analyzing my mistakes, I can honestly say I played right into all three risks I listed above. I didn't understand anything about Gamestop or its fundamentals (nor does it have any). The volatility scared me into selling (before it went back up again). And I couldn't accurately predict whether a hype cycle had just started or was beginning to end.
Why You Shouldn't Invest in Meme Stocks
Meme stocks took over the internet in 2021, but it's important to note the risks before investing.
A meme stock, by definition, is risky with no fundamentals (otherwise, it wouldn't be funny). On top of that, they also experience tremendous amounts of volatility and are ALL based on hype. If you can stomach all that, then by all means, go crazy. But if not, I'd highly recommend considering other options for where to place your money.
Happy wealth-building! That's all I have for today. I hope you've gained something valuable from this post and feel better informed about meme stocks and memes. Keep investing long-term in things you understand, and STAY AWAY from meme stocks.
Jeff is a current Harvard student and author of the blog Financial Pupil who is passionate about learning, living, and sharing all things personal finance-related. He has experience working in the financial industry and enjoys the pursuit of financial freedom. Outside of blogging, he loves to cook, read, and golf in his spare time.